Thank you for the PEPs, Lord Lawson

If you have the money to spare for stock market investment and you have not yet taken up this year's full allowance of personal equity plans (PEPs), I urge you to do so. PEPs are entirely free of both capital gains and income tax and are a wonderful incentive to invest in equities.

Basically, a PEP is a tax-free suitcase into which UK residents of 18 years and over can pack investments costing up to pounds 9,000 every year. These can be: ordinary shares of companies incorporated in the European Union and listed on any EU stock exchange, including London's Unlisted Securities Market, unit trusts, and investment trusts.

There is a pounds 6,000 limit for any or all of the above. A further pounds 3,000 can also be put into a single-company PEP, which invests in the shares of just one company. These limits apply to individuals, so a married couple can invest up to pounds 18,000 a year in PEPs.

Unit and investment trusts are divided into qualifying and non-qualifying trusts. To qualify, a trust must be at least 50 per cent invested in UK and EU shares, Only pounds 1,500 of the pounds 6,000 general allowance can be invested in non-qualifying trusts.

In my new book, Investment Made Easy, I explain how to select individual shares, investment trusts and unit trusts and how to invest in them through PEPs. There are also frequent articles on these subjects in the personal finance pages of most of the daily and Sunday newspapers.

Today, I am not interested in the twigs of the PEP tree; instead, I want to concentrate on one of the main branches. I believe that the attractions of PEPs have been under-estimated by many investors, who do not fully appreciate the cumulative effect of regular investment and capital growth.

Compound growth

Take, for example, a man and his wife who, between them, have enough earnings (coupled, if necessary, with personal savings) to take full advantage of their annual PEP allowance of pounds 9,000 each. Over seven years their portfolios could enjoy 20 per cent compound growth (a few well-managed trusts and many private investors comfortably achieve this kind of average with dividends reinvested). Their investment of pounds 63,000 each (7 x pounds 9,000) would grow to about pounds 140,000 each and a combined total of pounds 280,000. After another three years, the combined PEP portfolios would double to approximately pounds 560,000, churning out tax-free capital gains and income totalling well over pounds 100,000 a year.

Compounding is the key. Most people look at PEPs year by year; they compare their annual PEP limit of pounds 9,000 with the pounds 5,800 of tax-free capital gains that all investors are allowed anyway. This is a fundamentally wrong approach - PEPs should be looked at on a cumulative basis.

You will quickly see from the above statistics that, if you can afford to do so, you should take full advantage every year of the pounds 9,000 allowance for PEPs ( pounds 18,000 for a married couple). If you do not already have a PEP scheme, you can still form one for the 1993/4 tax year, provided you take action a few days before 5 April. From 6 April onwards, you will then be in a position to form another one for 1994/5.

Tax-free shelter

When Nigel Lawson introduced PEPs in his 1986 budget, he gave most small to medium-sized investors the opportunity to construct a tax-free shelter for all of their investment gains and investment income. Nine thousand pounds a year may not sound much, but it adds up very fast and quickly compounds with dividends reinvested and astute investment.

There is no doubt that shares are a superb long-term investment when compared with cash, gilts and building society deposits. There is however, always the risk of entering the market at just the wrong moment. By regularly investing pounds 9,000 a year in PEPs, whatever the state of the market, you lessen the impact of a possible crash and allow the averages to work for you. This way you can be reasonably certain of making substantial long-term capital gains coupled with growing investment income. PEPs will ensure that both are tax-free.